Foreign Investment In The Education Sector: Regulatory Roadblocks

The FDI Policy allows up to 100% foreign investment in the education sector under the automatic route (i.e. without the requirement of prior Government approval). Further, FDI in companies engaged in construction-development projects (including inter alia educational institutions) is permitted up to 100% under the automatic route, subject to compliance with certain conditionalities.

The education sector in India is one of the most dynamic sectors with immense potential for growth and investment. The education industry in India is estimated to reach USD 144 billion by 2020 from USD 97.8 billion in 2016 according to IBEF’s industry report of April 2018[1]. As per the Department of Industrial Policy and Promotion’s (“DIPP”) recent statistics on foreign direct investment (“FDI”)[2], the India education sector has received a cumulative foreign investment of around USD 1.67 billion from 2000 until December 2017.

The FDI Policy allows up to 100% foreign investment in the education sector under the automatic route (i.e. without the requirement of prior Government approval). Further, FDI in companies engaged in construction-development projects (including inter alia educational institutions) is permitted up to 100% under the automatic route, subject to compliance with certain conditionalities. However, despite the liberal FDI norms, investment in the education sector does grapple with certain regulatory hurdles restricting it from greater expansion and growth and some of them are discussed below.

Not for Profit Entity: The primary hurdle of investing in education is the ‘not for profit’ structure of the sector as education is treated as a service and not a business. Most Central and State level legislation in India require educational institutions to be run as ‘not-for-profit’ centers by ‘not-for-profit’ entities. These ‘not-for-profit’ entities can take the form of a society registered under the Societies Registration Act, 1860 or a public charitable trust, or a not for profit company registered under Section 8 of the Companies Act, 2013, subject to State-specific laws. Each of these entities cannot declare dividends or share profits and the surplus generated by such entities need to be plowed back into the institution for its betterment and growth. This inability to monetize their capital sometimes acts as a disincentive for the investors.

No FDI in Trust and Society: Limitations for Section 8 Company: As per the extant FDI regime, investment is prohibited in trusts (other than venture capital funds and investment vehicles regulated by SEBI) and societies. On the other hand, FDI in a Section 8 company is a possibility under the FDI policy. However, in terms of the Foreign Contribution (Regulation) Act, 2010 read with the FAQs available on website of Ministry of Home Affairs (“FCRA”), infusion of foreign capital in a Section 8 company, would be considered as foreign contribution, thereby requiring permission/registration from the Government prior to such infusion. The process of seeking registration/permission under the FCRA is a complicated and tedious one and requires onerous compliances vis-à-vis filings, maintenance of accounts and utilization of foreign contribution received. The difficulty is compounded by close monitoring of the usage of the funds on a yearly basis by the regulatory authority, thereby making the FCRA route quite unattractive to investors. Even otherwise, as the surplus generated by such Section 8 company would need to be re-invested into the institution, and no dividends can be distributed to its shareholders, this option loses its commercial feasibility further.

No Foreign Trustees or Members: To add to the woes of the investors, while there is no restriction under law for a ‘not for profit’ entity (like a charitable trust) running the school to have a foreign national as a trustee, from practical standpoint, the registering authorities often express their reservations in registering trusts in various States with foreign trustees (mostly for ensuring local access to the members for reasons of accountability). Further, in case such an operating entity intends to register under the FCRA for seeking foreign grants then they will not be permitted to appoint foreign trustees or members on their respective boards or governing body(s). Therefore, the inability of foreign investors to have a direct representation of the trust which is running the school acts as a dampener on investment prospects.

School Fee Regulation: The controversies surrounding fee regulations, the interference of the fee regulating committees and challenges faced by private schools vis-à-vis hiking of school fees in the last couple of years in various states including Gujarat, Tamil Nadu, Andhra Pradesh, Maharashtra, have also reduced the lure of the education sector for many.

In view of the aforesaid difficulties, investors often resort to innovative structures to invest in the education sector and to unlock the surplus generated by educational institutions. For instance, a commonly adopted structure is that of a three pronged model, where (a) the educational institution is run by a, not for profit entity (often a public trust); (b) the infrastructure of the educational institution is housed within a separate ‘for profit company’ which acquires, constructs and develops the school building and associated infrastructure and leases it to the education institution on a long term basis in exchange for lease rentals; and (c) certain management and supporting services such as provision of specialized content; teacher training; marketing and admission; maintenance and support; transportation, catering, housekeeping or security services etc. are outsourced by the educational institution to another ‘for profit’ entity, on an arm’s length basis.

Amongst other things, this structure minimizes the capital and infrastructure investment of the ‘not for profit’ entity running the school to a minimal and enables the ‘for profit’ entities to raise funds from investors (including under the FDI route) and render long terms services to the schools at arm’s length pricing.

However, these structures, are still sometimes not sufficient for investors who are looking to invest in India without the complications involved in implementing such multi-tiered structures. It is probably for the aforesaid reasons that many investors are increasingly veering towards investment in the online education sector, which sector is currently pegged at USD 2 billion and is expected to reach USD 5.7 billion by 2020 according to IBEF’s industry report of April 2018. The Bangalore-based online learning app, BYJU alone, for instance, has reportedly received investments from several huge investors like Chan Zuckerberg Initiative, International Finance Corporation, Verlinvest, and Tencent. Sectors such as pre-schools, private coaching, and tutoring, teacher training, the development and provision of multimedia content, educational software development, skill enhancement, IT training and e-learning have also become prime sectors attracting foreign investment, as they are largely unregulated. Therefore, it remains to be seen to what extent the more traditional brick and mortar education sector can attract foreign investment going forward given regulatory constraints of operating as a charitable enterprise.

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